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from MacroScope:

Shifting euro zone sands

A telling moment. Before pretty much every showdown EU summit since the debt crisis exploded into life, the leaders of France and Germany have got together beforehand to agree a common strategy. It is a truism that the European motor only works efficiently when its two biggest powers are in accord.

This time, following the election of Francois Hollande as French president, there has been no such meeting. Instead he will talk with Spanish premier Mariano Rajoy in Paris before they head to the Brussels summit. There, Hollande will press for the currency bloc to start issuing joint euro zone bonds and will run into implacable German opposition that will squash the plan for now. But the plates are shifting and German Chancellor Angela Merkel looks somewhat isolated.

On euro bonds, Hollande can call on the support of Italy’s Mario Monti and the European Commission among others. Nonetheless, Angela holds the purse strings so while we will see some modest pro-growth measures agreed (and no doubt trumpeted), there will be no pump-priming that requires extra deficit spending, certainly no mutualising of debt and probably no hint that the likes of Greece and Spain will be given longer to make the cuts demanded of them (though that policy's time could soon come, depending on how the June 17 Greek elections go).

Greek contagion aside, Spain remains the bloc’s biggest headache largely because of the weight of bad debts dragging its banking sector down. One idea is to allow the euro zone’s rescue funds to lend to banks direct, thereby removing the stigma of a government having to ask for aid. But Berlin is not keen on this one either.

Less controversial are plans to boost the capital of the European Investment Bank, use “project bonds” backed by the EU budget to invest in infrastructure and recalibrate some EU structural funds which has been used to help poorer EU members so that it is spent in other areas which might yield a quick growth dividend. None of that can hurt. But peashooters and elephants come to mind.

The golden rule of this crisis is that red lines have and will be crossed, most notably by Germany and the ECB, if the bloc is teetering right on the edge. The first ones to give this time may be on relaxing debt-cutting timeframes and allowing the bailout funds to help banks direct. Euro zone bonds remain a long way off (probably only when all member countries have got their deficits sustainably below 3 percent of GDP) and talk of a bloc-wide bank deposit guarantee fund isn’t anywhere near, though the pace of events could change that. Much hangs on how Greeks vote on June 17.

A demonstration of just how bent out of shape the euro zone is will be provided by today’s German 2-year debt auction. Yielding about 0.07 percent on the secondary market, that means Berlin has set a zero coupon for this sale and will pay no more to borrow this money over two years, yet investors are still expected to snap it up, such is the desperation for something secure. The debt agency says it is not planning to start offering negative coupons.

from MacroScope:

Merkel under pressure … but unbending

Some interesting events to  ponder over the weekend, though not many of them came from the G8 summit which, as is customary, was strong on rhetoric but bare of any specific policy measures to tackle the euro zone crisis. However, markets seems to have tired of their panicky last few sessions. German Bund futures have opened lower as investors took profits rather than seizing on any positive news. European stocks have edged up.

It does appear that with the ascension of France's Francois Hollande, the G8 firmament turned into G7 (or maybe 5 since we didn’t hear much from Japan and Russia) versus 1 (Germany) but as things stand we’re still heading for a fairly anaemic “growth strategy” unless euro zone leaders coalesce behind the notion of giving Spain and Greece longer to make the cuts demanded of them. Spain has moved the goalposts further in the wrong direction, revising its 2011 deficit up to 8.9 percent from 8.5 and blaming the overspending regions. That means its already loosened target of 5.3 percent for this year is now even harder to achieve.

Hollande is talking up the case for common euro zone bonds but that will not wash with Berlin for a long time yet. Sources said Monti used the G8 forum to promote a pan-European bank deposit guarantee fund. Good idea but that too will only be conceivable if the European financial sector is on the point of toppling. And who will underwrite it? There is talk too of allowing the EFSF to lend direct to banks to ease the Spanish government’s reluctance to ask for help. That may have a slightly better chance of success but Berlin doesn’t like this idea either. Look no further than the German Chancellor’s take on the summit – it was all a great success, she said. Everyone agreed that we need both growth and fiscal consolidation.

Angela Merkel is one the one with her hand on the purse strings and she knows the markets will only allow so much fiscal loosening. However, the hefty 4.3 percent pay rise secured by Germany’s most powerful union, IG Metall could be a sign that Berlin is starting to loosen the edges of its anti-inflation culture in order to foster a bit of domestic demand. Any profound return to euro zone growth is going to require some internal imbalancing – and that means Germany buying more from its partners to allow them to export more.

No one can accuse Merkel of being disengaged. Despite denials from Berlin, it seems she may have suggested to the Greek president that a referendum on euro membership should be held in parallel with the June 17 elections, a pretty astonishing intervention in another country’s democratic process.

It is certainly true that the mainstream, pro-bailout Greek parties’ only chance of doing better this time is to turn the election into a “euro in or out” poll by explaining why abandoning the bailout will open the exit door. But they have a lot of work to do to regain credibility. Of a series of opinion polls over the weekend, two put the anti-bailout SYRIZA ahead and another gave pro-bailout New Democracy the lead. Since the party who comes in first gets an extra 50 parliamentary seats, the tightness of the race is going to have markets on tenterhooks for the next four weeks. We had a nicely timed interview with SYRIZA leader Alexis Tsipras which ran overnight. He meets French leftist Melenchon today and is talking about building relationships and forging negotiations so Greece can stay in the euro. However, he will not be meeting government officials in France and said the terms of Greece’s 130 billion euros bailout were now a “dead letter” and noted what he saw as the changing dynamics at the G8.

In the meantime, Greeks continue to withdraw their money from the banks, a trend which if it reaches critical mass, could force a European policy response even before the election. If that starts taking root elsewhere, the whole system will be creaking. Spanish banks’ bad loans have hit their highest in 18 years and, with so much tied into a bankrupt property market, no one is quite sure how much worse it is going to get. Late on Friday, clearing house LCH.Clearnet raised the cost of using Spanish bonds to raise funds.

from Breakingviews:

Hollande-Merkel agenda is more Greece than growth

By Pierre Briançon

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

With growth on the menu and Greece on their mind, François Hollande and Angela Merkel have reasons to dispense with the usual niceties for their first meeting. The French president chose to fly to Berlin to meet the German chancellor on the very day of his inauguration - and not simply because he wants to smooth over some of the rough edges of the electoral campaign. His trip is also an acknowledgment that there is a fire in the euro house: neither France nor Germany can afford to waste any time before trying to put it out.

The best thing the two leaders could say about Greece after their meeting is nothing. Merkel, because any utterance will only add fuel to the Hellenic conflagration. Hollande, because at this stage he could only mouth platitudes on the topic. But public silence should be matched by intense private conversation.

Both leaders are challenged by the new crisis. Hollande must go beyond the campaign rhetoric about the need for growth-friendly policies in Europe: the initiatives he has in mind are irrelevant to the immediate risk of a messy Greek exit from the euro zone. For Merkel, the challenge is to avoid making her rigid stance on Greek austerity the main obstacle to the formation of a new government in Athens.

A productive conversation would lead to an either/or agenda. Either the Greeks can at last form a government able to negotiate with its creditors - in that case France and Germany should design the outlines of a face-saving deal - or an agreement proves impossible and Greece finds itself outside the euro. Then a contingency plan must be ready.

A deal will be difficult to achieve if it creates a precedent for unhappy governments willing to renege on the commitments made in exchange for aid. But Merkel’s Social Democrat opponents, emboldened by their recent electoral victories, are asking for some growth-friendly policies themselves. So the chancellor might be willing to make some concessions.

from MacroScope:

Can Greek public opinion be turned?

So we’ve got the fresh Greek elections we expected and markets, despite the inevitability that we would get here, have reacted with some alarm. European stocks have shed  around 1 percent, and the harbour of German Bunds is pushing their futures price up in early trade. The Greeks will try to form a caretaker government today to see them through to elections expected on June 17.

The key question is whether the mainstream parties can mount a convincing campaign second time around, playing on the glaring contradiction in SYRIZA’s position (no to bailout, yes to the euro) and essentially turning the vote into a referendum on euro membership, which the overwhelming majority of Greeks still support. Don’t count on that. SYRIZA remains ahead in the polls. To be able to pull it off, PASOK and New Democracy will need some help from Europe. There have already been hints from Brussels that if a pro-bailout government is formed, Athens could be given some leeway on its debt-cutting terms. But equally other voices are saying there is no more room for manoeuvre.

France's Francois Hollande used his presidential debut to frame help for Greece within his push for a European growth strategy last night, saying he hoped that could also foster a return to prosperity there. He and Germany's Angela Merkel are due in the United States for a G8 summit at the end of the week where doubtless they will come under heavy pressure to make sure Greece doesn’t bomb out of the euro zone or, if it does, that the effect is contained. Easier said than done. Given a Greek euro exit would probably require rapid concerted reaction from the EU, IMF (to shore up Spain?) and the world’s big central banks (remember the global monetary policy response after the collapse of Lehmans?), planning for that could well be bubbling below the surface at the G8.

IMF chief Christine Lagarde said last night that it was important to be technically prepared for the possibility of Greece leaving the euro zone while Finland’s prime minister said Greek euro exit would not cause the financial mayhem seen in 2008.

As we’ve said before, Greece has some leverage. The IMF, ECB and euro zone governments are holding a lot of Greek debt so have an incentive to keep the  show on the road or face heavy losses if there is a hard default. Of Greece’s 250 billion-plus euros of debt, nearly 200 billion is now held by those public bodies, most of it by the ECB, which could need recapitalizing after that sort of hit, something that would fall back on euro zone governments. It is also hard to see how Europe could avoid propping Greece up even if it did leave the currency club. The calculation for euro zone leaders is whether pouring good money after bad is more or less palatable than taking a big loss on their Greek debt holdings.

On the growth strategy, there are hints that Spain will get more time to hit its 3 percent of GDP budget target, so why not something similar for Greece? PASOK leader Venizelos, the man who negotiated the bailout and who was humiliated in the election 10 days ago, has pressed for three years rather than two to make the cuts required by Greece’s programme. If he got stronger signals from euro zone partners that something like that could happen – and persuaded the electorate that this is the only way to avoid euro exit  -- it’s possible that he and New Democracy leader Samaras could do better second time around. The problem for the markets is that while you can take a reasonable stab at how politicians might act, it’s much harder to read a battered electorate. So they are in for a rocky month.

What is undeniably true is that the piecemeal European growth measures announced so far to revive moribund economies don’t amount to a hill of beans.

from MacroScope:

Greek tragedy

Greece is stumbling inexorably towards fresh elections which polls suggest will give the anti-bailout far left a stronger grip on power. Last ditch talks aimed at creating a unity government will continue under the aegis of the president today but the leader of the radical leftist SYRIZA has said he will not turn up. Alexis Tsipras says he wants Greece to stay in the euro but will rip up the bailout agreement. Go figure. This morning the more moderate left party has said it won’t take part in a government lacking SYRIZA.

A big question is whether the mainstream parties can mount a convincing campaign second time around, playing on the glaring contradiction in SYRIZA’s position and essentially turning the vote into a referendum on euro membership, which the overwhelming majority of Greeks still support. Don’t count on that.

Two ECB policymakers --  Honohan and Coene – were out over the weekend talking about the possibility of a Greek euro exit: there goes another taboo. Policymakers must be running through the hard default and exit scenarios now. We need to be asking.

As we’ve said before, Greece has some leverage. The IMF, ECB and euro zone governments are holding a lot of Greek debt so have an incentive to keep the  show on the road or face heavy losses if there is a hard default. Of Greece’s 250 billion-plus euros of debt, nearly 200 billion is now held by those public bodies. It is also hard to see how Europe could avoid propping Greece up even if it did leave the currency club. The calculation for euro zone leaders is whether pouring good money after bad into Greece is more or less palatable than taking a big hit on their Greek debt holdings.

Greece will obviously loom large over this evening’s meeting of euro zone finance ministers in Brussels. But so will Spain. There is talk of Madrid getting some leeway on its deficit-cutting targets after the European Commission predicted on Friday they would be missed. But first it will have to present a more credible 3-4 year plan on how it will get there. So don’t expect anything definitive today. Spain is grappling with its bad bank debt problem but the 84 billion euros it has told banks to put aside still looks shy of what’s needed. Either government or euro zone money is likely to have to come to the rescue at some point. So far banks have responded with plans that do not require state aid, apart from Bankia which was essentially nationalized last week.

If Spain is cut some slack then why not Greece? (maybe because it has been bailed out twice). Venizelos, the finance minister who negotiated the second bailout, has suggested Athens gets three years instead of two to produce the cuts demanded in its loan programme. If that happened, Portugal and Ireland would presumably demand better terms for their bailouts but it’s not impossible – we’re clearly into policymaking directed at the lesser evil here.

A hefty defeat for Angela Merkel in a key state election on Sunday may not help her bend the rules to keep Greece going. But as regards a euro zone growth strategy -- a hot topic this week with Francois Hollande rushing to Berlin for a debut visit -- the fact the centre-left SPD, who have argued against austerity for austerity's stake, cleaned up in North Rhine-Westphalia is interesting. Another prominent growth proponent, Mario Monti, said on Sunday that Italy's social fabric is being torn by recession and tensions are growing among its citizens. It looks like there is a growing resolution that the end-June EU summit must come up with more profound growth measures than anything currently on offer. More time to meet deficit targets looks like the obvious option.

from MacroScope:

The end of austerity? Not likely

It was Bill Clinton who, after the 2000 U.S. election was thrown into turmoil by Florida's hanging chads, said the American people had spoken but it was going to take a little time to work out what they had said. No such dilemma in Greece. A plague on both your houses was the message for the traditional ruling parties PASOK and New Democracy, a result that makes a stable government look a remote possibility and puts a very real question mark over its bailout programme.

Today, the largest party New Democracy will try to form a coalition. Given what they've said, the left-wing Left Coalition which leapfrogged PASOK into second place cannot be part of a government committed to the bailout terms so it looks like the two traditionally dominant parties -- two seats short of an overall majority between them -- must seek support from elsewhere or face fresh elections which could well give an even more fractured result. One thing worth noting is that even the resurgent anti-bailout parties mostly say they want to stay in the euro zone so maybe there's soom room for negotiation.

The euro has dived to a three-month low, Bund futures have posted yet another record high and European shares are down so we're right back in fear mode.

Two big questions flow from all that: 1. Could this vote, and socialist Francois Hollande's victory in France, shift the growth/austerity debate? 2. Does Greece, even its possible euro exit, still have the power to spread damaging contagion to the rest of the euro zone?

On the growth front, the answer is only up to a point because Berlin and the European Central Bank -- and the markets -- won't wear anything that will dilute debt-cutting programmes much, whatever the more friendly rhetoric suggests. Italian premier Mario Monti, a man desperate for growth, talked to Hollande, Germany's Angela Merkel and Britain's David Cameron among others after the elections last night, presumably to push that agenda and the argument is gaining force.

EU economics chief Olli Rehn chipped into the growth debate over the weekend, suggesting there is some leeway to temper debt-cutting drives in order to leave scope for growth. But again, details were elusive. Rehn also said those countries under the  microscope had to convince the markets and policymakers of their capacity to put their fiscal houses in order. This sounds rather like having your cake and eating it, or at least reaffirms what we've been saying -- that there may be some limited fiscal wiggle room, but only as much as the markets will allow, which is not much.

So the growth strategy stills seems to rest on structural reforms (which will take years to bear fruit), plus reconfiguring some EU funds and a beefed up European Investment Bank. Those who really count -- Merkel and Draghi at the top of the list -- are talking up growth measures while insisting the austerity drive must not be dimmed. The markets would probably respond well to stimulus which did not fundamentally undermine debt reduction. But that's some trick. And what's on offer so far will not do the trick. Will something more profound be cooked up for the end-June EU summit?

from MacroScope:

Euro election fever

We will return on Monday knowing whether the Greeks have elected a pro-bailout government and probably to find socialist Francois Hollande – the man leading the growth strategy charge – as the new French president. 

An Hollande victory could cause some jitters given his rhetoric about the world of finance. But we’ve looked at this pretty forensically and there may not be much to scare the horses. Yes he is making growth a priority (but even the IMF is saying that’s a good idea) yet his only fiscal shift is to aim to balance the budget a year later than incumbent Nicolas Sarkozy would. Contrary to some reports, he is not intent on ripping up the EU's fiscal pact and of course the bond market will only allow so much leeway.

The heavyweight Economist magazine may have labelled socialist Hollande “dangerous” but the reality is likely to be that he will rule from the centre and his demands for a dash for growth -- and a change to the ECB's mandate to aid it -- will be tempered. Spain has shown everybody that too much fiscal loosening will be pounced upon by the bond market and while there is a lot of talk about a growth strategy for Europe, what we've heard so far amounts to tinkering.

 While an Hollande victory looks priced in, Greece still has some power to shock the euro zone.

If the two main Greek parties – PASOK and New Democracy – fail to win enough votes to govern together, they may have to turn to a fringe anti-bailout party which would put a big question mark over Athens’ ability to  stick with the austerity terms demanded by its international lenders. However, the threat of contagion, while still alive, has shrunk. With creditors already having taken a massive haircut, most non-Greek banks completely out or at least having written down anything they hold, a 500 billion euros rescue fund shortly to be in place and the IMF raising an extra $430 billion of its own, the power Greece has to start a domino effect in the euro zone is diminished. The caveat to that is, if it has to be cut some slack by the EU and IMF, Portugal and Ireland would presumably demand the same and then the whole austerity edifice starts to look wobbly again.

Despite the much vaunted growth strategy, the focus remains on structural reforms (which will take years to bear fruit) plus reconfiguring of some EU funds and a beefed up European Investment Bank. It will help, or at least can’t hurt, but what’s being discussed so far does not look like anything like a game changer, breaking the spiral of debt-cutting  deepening economic downturns which in turn will make it yet harder to cut debt.

And those who really count -- Merkel and Draghi at the top of the list -- insist the austerity drive must not be dimmed. The markets would probably respond well to growth measures which did not undermine debt reduction. But that's some trick.

from MacroScope:

Tumultuous euro zone week

A week where every facet of the euro zone debt saga will come from all angles.

The major events are the French presidential run-off and Greek general elections on Sunday, May 6.   In the former case, a likely socialist Francois Hollande victory could cause some market jitters given his rhetoric about the world of finance. But we’ve looked at this pretty forensically and actually there may not be much to scare the horses. Yes he is making growth a priority (but even the IMF is saying that’s a good idea) yet his only fiscal shift is to aim to balance the budget a year later than Sarkozy would. And, contrary to some reports, he is not intent on ripping up the EU’s new fiscal rules. And of course, the bond market will only allow so much leeway.

If the two main Greek parties – PASOK and New Democracy – fail to win enough votes to govern together, they may have to turn to a fringe anti-bailout party which would put a big question mark over Athens’ ability to stick with the austerity terms demanded by its international lenders.

Even if fears about a hard Greek default or even euro exit result, the threat of contagion looks far smaller. With creditors already having taken a massive haircut, most non-Greek banks completely out or at least having written down anything they hold, a 500 billion euros rescue fund shortly in place and the IMF raising an extra $430 billion of its own, the power Greece has to start a domino effect in the euro zone is very much diminished.

Netherlands’ fractured political parties have managed to put together a budget deal in time to present it on deadline to Brussels on Monday but Spain remains far more a source of concern. Downgraded again, its borrowing costs have soared since the government loosened its 2012 deficit target in March. Data just out shows the Spanish economy has succumbed to recession again. Madrid will hold a bond auction on Thursday, as will France.

As we’ve been saying for a while, hopes that the ECB cavalry will ride to the rescue are wide of the mark, until and unless the crisis takes a distinct turn for the worse.

The European Central Bank holds its monthly meeting in Barcelona on Thursday. No policy change is expected and Mario Draghi will doubtless re-emphasise that by creating more than a trillion euros of three-year money, the ECB has bought time for governments and banks to put their own houses in order. There will be a strong focus on his latest call – for a “growth compact” – though it seems to focus mainly on structural reforms and some capital spending out of EU funds, i.e. nothing that the ECB has to get involved in.

from Ian Bremmer:

Make no entangling foreign frenemies

It’s often said that kinship runs deeper than friendship. Lately, when it comes to chumminess among world leaders and their colleagues in neighboring countries, friendship has trumped citizenship.

Until recently, it was rare to find leaders willing to forge friendships with candidates across borders or to find would-be leaders campaigning inside foreign countries. There are good reasons for that: Candidates who cross these lines can find it harder to win elections or to govern once the electoral test is passed. Their foreign friends can pay a price for backing the wrong horse and for forfeiting a bit of diplomatic leverage once they find themselves sitting across the bargaining table from the man or woman they campaigned against. Consider three current examples.

Angela Merkel and Nicolas Sarkozy

German Chancellor Angela Merkel’s support for the re-election bid of French President Nicolas Sarkozy is especially startling. It’s hardly surprising that Merkel wants Sarkozy to win. The two leaders have forged a durable personal relationship as they navigated their way through Europe’s ongoing crisis of confidence. The French and German leaders deserve considerable praise for their well-coordinated bid to bolster the euro zone.

But for Merkel, there’s a big difference between privately willing Sarkozy on and campaigning at his side across France – particularly at a time when Sarkozy trails Socialist Party challenger François Hollande significantly in opinion polls. Given the populist mood in France, Merkel’s stated reasons for supporting Sarkozy – that he is a conservative candidate whose party is philosophically aligned with her own Christian Democratic Union – sounds less like a boost for his campaign than a nail in his coffin.

from John Lloyd:

For Europe, it doesn’t get better

The European crisis isn’t over until the First Lady pays, and the First Lady of Europe, Angela Merkel, cannot pay enough. She needs to erect a large enough firewall to ensure that the European Union’s weaker members do not, again, face financial disaster. That will not happen – which means the euro faces at least defections, and perhaps destruction.

The crisis had seemed to recede somewhat in early 2012, and the headline writers moved on. But it had only seemed to recede, and relaxation was premature. As Hugo Dixon of Reuters’ Breaking Views put it on Monday, “the risk is that, as the short-term funding pressure comes off, governments’ determination to push through unpopular reforms will flag. If that happens, the time that has been bought will be wasted – and, when crisis rears its ugly head again, the authorities won’t have the tools to fight it.”

But the underlying tension remains between high indebtedness in nearly all the EU countries and the need to pare back public spending without suffocating the economies. The flat, or negative, growth lines in the same countries that are indebted are likely to be made worse as demand falls and a malign cycle threatens.

Merkel commands the stage, but she is a constrained commander. She has an electorate and a parliament that has been reluctant to agree to more assistance to those whom many Germans see as architects of their own misfortune, not to be trusted to do anything other than load the burden on to the backs of hard-working Northerners.

In other parts of the Union, signs of strain now manifest themselves daily. In France, the leading candidates – President Nicolas Sarkozy and Socialist contender François Hollande – have turned inward and, in the words of a sharply worded Economist editorial, while “it is not unusual for politicians to ignore some ugly truths during elections … it is unusual, in recent times in Europe, to ignore them as completely as French politicians are doing.”

Sarkozy has transformed himself from responsible European statesman into an anti-immigrant, anti-free-trade superpatriot (and his ratings improved). Hollande, from the Socialist Party’s moderate wing, has likewise transformed, but into a “hater” of the rich. Both see strong contenders to their right and left: Marine Le Pen of the far-right Front National has faltered recently – perhaps because Sarkozy has stolen some of her clothes – but she still polls at around 14 percent. And on the left, former Socialist minister Jean-Luc Mélenchon has swung hard-left, put together a group that includes the Communist Party, and seen his support rising in the latest poll, for LH2/Yahoo, up to 15 percent so far.

Britain is not in the euro but is deeply dependent on European resurgence. Its Conservative-Liberal coalition government finds itself faced with strikes by tanker drivers – men with a capacity for squeezing a nation’s windpipe – and plunging polls. Nor is anyone else enjoying support. All the main party leaders see their ratings deep into negative territory; and in a by-election last week, the renegade Labour MP George Galloway played for and won a heavily Muslim vote in the city of Bradford, destroying a long-held Labour majority.